Q: What is “tail risk”?
Bhansali: Tail risk can be defined as the risk posed by events that are relatively rare, but that can have substantial impact on a portfolio. These rare events can cause outsized gains or losses for investors. We are most concerned with the tail risks that can severely damage portfolios.

Tail risk refers to the risk of potential investment outcomes on the edges of statistical return distributions. In a typical bell curve, the tallest areas near the center represent the more likely outcomes. The “tails” are where the bell curve tapers down toward the edges. Of course, there are both left tails and right tails, but having a long-term view requires special attention to the avoidance of catastrophic losses, or left tails. Because real markets don’t neatly follow the bell curve, underestimating the likelihood and severity of events on the tails can result in extreme losses.

Traditional risk management and pricing tools often underestimate the frequency and severity of these left tail events and, by extension, their detrimental effect on returns. Investors who fail to account for tail risk will likely eventually suffer, as recent events have demonstrated, and long-term returns may fail to meet their investment objectives.

Q: What is “OTD”?

Originate-to-distribute (OTD) model of lending, where the originator of a loan sells it to various third parties, has become a popular vehicle for credit ...